European Bank Bondholders May Look to Ireland for Hints of Fate

By Dara Doyle and Joe Brennan -
Oct 27, 2011

European lenders looking to raise
106 billion euros ($148 billion) might turn to Ireland, the home
of the region’s worst banking crisis, for a blueprint.

Goldman Sachs Group Inc. said today “liability management
exercises” are one avenue for recapitalizing Europe’s banks
under rules laid out by regulators late yesterday in response to
the euro area’s sovereign debt crisis. That’s code for sharing
losses with junior bank bondholders, a strategy pioneered by the
Irish to cut the cost of saving their financial system.

“There’s a range of options for the European banks, like
asset sales and liability management exercises,” Eamonn Hughes,
banking analyst at Goodbody Stockbrokers in Dublin, said today.
“They can look for a few hints from Ireland’s experience.
Ireland is a test case for capital raising.”

Ireland has raised 15 billion euros, equal to about 10
percent of the country’s economic output, since 2009 from
sharing losses with investors after the collapse of the real
estate market sank the financial industry. Ireland introduced
emergency laws last year allowing the state to impose losses on
junior holders of bank bonds.

As part of their package aimed at tackling the debt crisis
agreed during the night, European leaders said in a joint
statement today that banks in the euro region should raise
capital including “through restructuring and conversion of debt
to equity instruments.”

Taking Hints

“Policy makers seem determined to use subordinated debt
instruments to help recap the banks,” Richard Thomas, London-
based analyst at Bank of America Corp.’s Merrill Lynch, said in
a note. “Whether banks take the hint is another matter.”

The European Banking Authority estimates Spanish banks
require 26.2 billion euros of extra money and Italian banks 14.8
billion euros. It gave them until Dec. 25 to submit money-
raising plans to national supervisors.

Banks that fail to raise enough capital in the markets will
first tap national governments, falling back on the European
Financial Stability Facility rescue fund only as a last resort.

Irish banks don’t need to raise extra capital, the banking
authority said. That “reinforces the robust and conservative
nature” of a capital review by the country’s authorities in
March, Irish Finance Minister Michael Noonan said last night.

In all, Ireland has injected about 62 billion euros into
its financial system and the government now controls five of the
country’s six biggest lenders. In the March stress tests, banks
were ordered to raise 24 billion euros. The state’s contribution
was reduced to about 17 billion euros, partly because losses
were imposed on junior bondholders.

Learning Lessons

“I’d say they’d be looking very closely at what we’ve
done,” said Michael Torpey, a banking official at Ireland’s
Finance Ministry, told reporters in Dublin today. “If I was
sitting in another country, I’d be saying, ‘Let’s see what
lessons we can learn. We don’t have to copy them exactly.’”

Allied Irish Banks Plc (ALBK), now 99 percent state-owned, said in
July it would raise about 2 billion euros from buying back
subordinated bonds after inflicting losses of as much as 90
percent on investors. Had holders not accepted, the new laws
meant they faced losing virtually all their investment.

It may not be that bad for European bank bondholders,
because withholding dividends and selling assets may reduce the
amount financial companies need to raise.

“We do expect more liability management trades but suspect
that the levels of capital needing to be raised aren’t
sufficiently challenging to mean very negative outcomes for
bondholders in most cases,” said Thomas at Bank of America.

Torpey said the approach in various countries may vary with
the depth of their banking problems compared with Ireland. The
collapse of country’s financial system forced Ireland to seek an
international bailout last year.

“If I was sitting in one of the other countries, one of
the questions you’d ask is what is the scale of capital
raising,” Torpey said. “If there are countries which have
problems that are as deep, then they have to be prepared to look
at solutions that are as severe.”